Bank of England governor Mervyn King said the outlook for the UK economy had 'deteriorated' blaming concerns over debt in the eurozone and fiscal policy in the United States for a downturn in market mood.

GDP is set to grow by around 1.4 per cent in 2011, the Bank said in its quarterly inflation report, down from its estimate of around 1.8 per cent in May.

Growth will remain sluggish in the near term, reflecting the continued squeeze on household incomes, but the Bank said it is likely to be above normal levels by 2014.

UK economic outlook has deteriorated

Bank of England governor Mervyn King

It warned that the near-term squeeze on consumer spending is set to continue and there is a "good chance" inflation will reach 5% in the coming months, driven by rises in utility bills.

"The outlook for growth in the world economy has deteriorated and, largely as a consequence, near-term growth prospects at home are somewhat weaker," Sir Mervyn added.

The Bank also noted that the Japanese tsunami and rises in oil prices had depressed growth in the short term and warned that some of the slowdown will be more persistent.

In addition, the debt crisis in the eurozone has the potential to impact significantly on the UK economy.

Sir Mervyn said: "There are a number of headwinds to world and domestic growth over the forecast period, not least the private and public debt overhang. And these headwinds are becoming stronger by the day."

Max Johnson, broker at the forex specialists Currency Solutions, commented: "In just a few pages of data, this latest quarterly inflation report paints a bleak picture: an economy with gloomy prospects and a central bank with an almost impossible task.

"Once again the Bank of England has downgraded the UK's growth forecast. And rightly so: after nine months of stagnation, the economy is stubbornly refusing to pick up.

"The hoped for export-led recovery has failed to materialise. Even though the weak Pound has kept British goods cheap, our main customers in the Eurozone and the US have had their own problems and simply haven't been buying. There are no signs whatsoever that this will change in the short and even medium term as the global debt problem continues.

"So while the Bank is condemned to more chasing of its own tail, prospects for the economy and the Pound look sombre.

"While weak, Sterling is at least stable. With so much volatility bedevilling other currencies, Sterling can take some solace in its image as a somewhat dull safehaven currency. Given the depth of the crisis at home, that says a lot about the extent of the problems overseas."

Economists said the report appeared to endorse expectations that interest rates will remain at 0.5 per cent for a sustained period.

Vicky Redwood, senior UK economist at Capital Economics, said: "What's more, even the MPC's (monetary policy committee's) downgraded growth forecasts look optimistic to us, particularly in light of the market volatility seen since the Bank signed off the report.

"Accordingly, we still think that keeping interest rates low won't be enough and that more quantitative easing will be necessary."